Monday, February 09, 2009

Need for Stimulus

A question arises as to the need for continuous spending. ie...If President Bush spent so much money to get us into this problem, why is it that more spending will get us out of this problem?
The resultant theory is that inflation was in a downward spiral under President Bush. However, with a war time economy in place government spending cannot be controlled to maximise economic efficiency. Government spending pushed the US into a recession. The federal funds rate is at less than 1 percent. Traditional methods of controlling inflation is the increase of interest rates. No matter what the various expenditures were, so much money was in circulation that inflation was totally halted and even reversed. Federal funds dropped to compensate a recession. With federal funds unable to go any lower we are at risk of entering deflation. During deflation, business that hold onto hard currency benefit the most and that is a part of the reason banks are not lending. Federal Reserve Chairman Ben Bernake said in 2002 that sufficient spending always reverses deflation. During deflation the purchasing power of each dollar rises because prices are falling. However, falling prices makes it difficult to make payroll. So the dollar does purchase more, but less dollars are earned due to an increase in unemployment. Inflation is easier to control than deflation due to the effects of increasing interest rates. Deflation is controlled with large amounts of government spending because the unemployment rate and benefits of keeping cash and not lending it force government to resort to "stimulus" spending. Its the textbook response to take when federal funds can go no lower. What may sound like "more of the same" is actually an appropreate textbook response to a totally different part of the economic cycle at hand.

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